Compliance August 14, 2019

ERISA Complaint Questions Alternatives Use in Custom TDF

Retirement plan fiduciaries at Intel are accused of exposing investors to bets on speculative areas of the markets.

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As it awaits the results of a Supreme Court appeal on another case scrutinizing its investment decisions, Intel Corporation now faces an additional lawsuit questioning the fees and performance of custom target-date funds (TDFs) offered to its defined contribution (DC) retirement plan participants.

The lawsuit, filed in the U.S. District Court for the Northern District of California, suggests a number of Intel defendants breached their fiduciary duties by investing billions of dollars of employees’ retirement savings in “unproven and unprecedented investment allocation strategies featuring high-priced, low-performing illiquid and opaque hedge funds.”

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Case documents show the lead plaintiff is a participant in two Intel retirement plans, bringing this action on behalf of a class of similarly situated participants. According to the plaintiff, Intel plan fiduciaries “deviated greatly from prevailing professional investment standards for such retirement strategies in several critical ways.” Chief among them, according to the lawsuit, is the investing of billions of dollars in hedge funds, private equity and commodities.

“And then, as investment returns repeatedly lagged peers and benchmarks, [plan fiduciaries] did nothing while billions of dollars in retirement savings were lost,” the complaint states. “[Defendants] deviated from the standard of care of similarly situated plan fiduciaries who select target-date funds for their plans that include little or no exposure to these strategies.”

The complaint further states that Intel defendants failed to properly monitor the performance and fees of either the custom TDFs or of a custom multi-asset portfolio with a fixed allocation model that is also available to participants. The complaint says defendants failed to properly investigate the availability of lower-cost investment alternatives with similar or superior performance and failed to properly monitor and evaluate the “unconventional, high-risk allocation models adopted for these custom investment options.”

Additionally, the compliant states, Intel defendants failed to provide adequate disclosures associated with the custom investment options’ “heavy allocation” to hedge funds and private equity, and either misinformed or failed to inform participants about the allocation mix of their account balances and the allocation strategy of the custom options.

“As a result of these imprudent decisions and inadequate processes, defendants caused the plans and many participants in the plans to suffer substantial losses in retirement savings,” the complaint alleges.

Stretching over 100 pages, the complaint includes substantial detail about the process Intel allegedly used to create and manage the custom funds. Notably, until January 1, 2018, the Intel TDFs and multi-asset funds were not technically funds—as there was no distinct legal entity such as a mutual fund or collective trust that held the investments. Rather, they were allocation models that directed participant savings into various pooled investment funds. Each of these pooled investment funds was structured as a collective trust. Effective December 31, 2017, the Intel models were converted to standalone collective investment trusts.

According to plaintiffs, throughout the history of these investment strategies being offered, participants have consistently been charged fees significantly higher than both actively managed and passively managed target-date series offered by professional asset managers. At the same time, plaintiffs allege, the custom investments have demonstrated substantially worse performance, both in absolute terms and on a risk-adjusted basis.

Readers may be aware this is in fact at least the second lawsuit Intel faces questioning its decisions in offering custom investments. Back in November 2015, plaintiffs first filed what has now proved to be a long-running compliant that similarly alleges fiduciary failures by various Intel defendants. That case, Sulyma v. Intel Corporation, was initially decided in favor of Intel on statute of limitations grounds. However, the 9th U.S. Circuit Court of Appeals overturned the ruling in December 2018, finding that disputes of material fact exist as to the timing of the plaintiff’s actual knowledge of the alleged fiduciary breach, precluding summary judgment for untimely filing. This appellate ruling in turn has been accepted for review in the next term of the U.S. Supreme Court.

The Sulyma case is potentially quite significant in that the question of what creates “actual knowledge” plays directly into arguments of timeliness under ERISA. In basic terms, this is because the timing of when “actual knowledge” of a potential fiduciary breach is established is used to define when one of several potential statues of limitations will start to run for a given fiduciary action or decision.

The full text of the new complaint is available here. 

Products August 14, 2019

Will Trump Administration Prove Friendlier to Retirement Plan Innovators?

After previously failing to get DOL approval for a target-date fund design that involves an annuity and reinsurance component, LGIMA hopes the Trump Administration will more readily allow such private sector innovations.

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During a recent discussion on the topic of market volatility and pension plan trends, Jodan Ledford, head of client solutions and multi asset for Legal & General Investment Management America (LGIMA), shared that his firm has restarted work on an innovative new target-date fund (TDF) design.

In simple terms, the fund LGIMA hopes to roll out will be a TDF that features a built-in insurance component that will allow investors to “hit the easy button” to annuitize a given portion of their lump sum balance.

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The fund would be supported, Ledford explains, by what is essentially a heat map that can be displayed in the participant’s investment portal. This heat map would show whether or not the current market conditions present a favorable or unfavorable annuity purchase window. According to Ledford, by having the embedded insurance component, plans could potentially save the participant somewhere in the ballpark of 8% to 10% of the cost of an annuity transaction. An advice component can also be linked into the TDF approach.  

Perhaps the most interesting feature of this architecture, Ledford says, is the fact that the target-date fund is being designed to own a reinsurance entity for the annuity provider. This arrangement would mean that the longevity profits the insurance company would make on the annuitized assets (and normally keep for itself) could instead be fed directly back to younger participants via dividends.

Not a New Idea

While Ledford is excited about this TDF design idea, he notes that it is, in fact, not new. LGIMA first brought this new TDF-annuity schematic to the Department of Labor (DOL) for approval about four years ago.

“When we went to the DOL some years ago, we told them we were trying to put a schematic together for a TDF that would effectively have a captive insurance capability inside of it. We explained that our goal is addressing the retirement income crisis,” Ledford says. “At that time, the response we got from DOL was actually quite skeptical. The DOL asked, where are you fleecing the participant in this complex product?”

According to Ledford, he and his colleagues emphasized their intention was, in fact, to help participants, and that LGIMA’s business incentive was to create a new product to solve a specific and critical marketplace need.

“In the end, they couldn’t get their heads around it,” Ledford says. “They kept trying to find where we were trying to take out double or triple fees on the participant.”

A More Responsive DOL?  

Fast-forward to 2019 and LGIMA is again working with outside counsel to readdress this new TDF framework.

“Encouragingly, we have gotten indications that the Trump Administration’s DOL is much more open to these kinds of discussions and innovations,” Ledford says, adding that he was not surprised to see the recent news that Nationwide has received a positive IRS private letter ruling. That ruling essentially conforms the tax treatment of properly structured advisory fees from non-qualified annuity contracts to those paid out of qualified accounts, which typically are not treated as taxable distributions.

According to Craig Hawley, head of Nationwide Advisory Solutions, that IRS ruling solves one of the biggest friction points that have held back many fiduciary advisers from the use of fee-based annuities. Hawley says he believes the ruling “opens the door to allow advisers to use these solutions in a much more significant fashion.”

Ledford agrees with that assessment, saying he is encouraged and hopeful that LGIMA will be allowed to move forward with much-needed innovations in the retirement income domain.

“Overall, the current Administration wants to promote market innovations, and I think they also realize there is a real retirement income crisis here,” Ledford says. “If we don’t allow private sector innovations to solve the retirement income challenge, we will end up with a very big social welfare risk on the backs of the taxpayers. From that perspective, too, I think the mood has changed.”

Beyond TDFs, Time to Focus on DC

While LGIMA predominantly works with pension plan clients, Ledford says, the business is shifting to think more about the defined contribution (DC) plan marketplace.

“In fact, we are bringing together some of the insurance and asset management capabilities into one standalone business unit that I will oversee,” Ledford explains. “Beside the new TDF, on the DC side, we are quickly moving towards the ability to be able to deliver a holistic and innovative post-retirement income framework. We’re trying to bring flexible income solutions for the first part of retirement—ages 65 to 80 or 85. These can be paired with in-plan deferred annuities that already enjoy the DOL’s approval, such as qualified longevity annuity contracts.”

Outside of the retirement plan context, LGIMA is looking at developing retail fixed annuities that, as Ledford puts it, “avoid all the nastiness of the variable markets, but still allow a premium to grow over a deferral period, such that it can outperform inflation.”

“The goal is that, by the time you commenced taking the annuity at a later life stage, your income power will remain what it was when you retired—or potentially even improve,” Ledford says. “We think this is a very innovative approach that could do a lot to help the majority of people who are facing retirement without a defined benefit pension plan.”

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